I’m a tax lawyer based in San Francisco (www.WoodLLP.com), but I handle tax matters everywhere. I enjoy untangling a tax mess from the past, disputing taxes with the government or planning taxes for the future. One of my specialties is advising about lawsuit payments. Whether you’re receiving or paying a legal settlement, you can probably improve your tax position. I write frequently about taxes, from expatriation to sales tax, from selling your company to restitution. I’ve written over 30 tax books, but my best seller is still Taxation of Damage Awards and Settlement Payments. Contact me at wood@WoodLLP.com.

$1.5 Billion UBS Fine? Much Less After Taxes

Swiss bank UBS is coughing up $1.5 billion and pleading to a single count of wire fraud in connection with manipulation of Libor interest rates. The Financial Times reported that three dozen UBS employees would be implicated. Some face criminal charges. Is that the last word?

After tax, it could be a lot less. It is hard to tell what is penal in nature and what could be tax deductible, but it’s likely someone is considering appropriate tax reporting positions. Is that inappropriate? Not necessarily.

Most payments in business are deductible, even punitive damages. SeeCan Rolls-Royce Deduct Bribes? How About Fines?However, the tax code prohibits deducting ‘‘any fine or similar penalty paid to a government for the violation of any law.’’ See IRC Section 162(f). That includes criminal and civil penalties, yet many companies are able to deduct fine-like settlements.

If a fine or penalty is intended to be punitive, it is probably nondeductible. But if it is remedial in nature, it may be deductible despite its “fine or penalty” name. Environmental payments and other payments to governmental entities may qualify.

Example: Suppose you pay a $100 million fine. If it’s nondeductible, it costs the full $100 million. But if you are in a 40% tax bracket and can deduct it, the fine actually costs you $60 million after tax. Exxon’s $1.1 billion Alaska oil spill settlement actually cost Exxon $524 million after tax. See BP, Oil, and Deducting Punitive Damages.

It is sometimes possible to settle with a government agency and to address this issue. The settlement agreement may specify that a fine is remedial rather than punitive in character. Yet sometimes tax deductions land companies in court a second time. See Tax Deductions for Damage Payments: What, Me Worry?

After McLaren somehow had secret Ferrari documents, McLaren was hit with a €40m fine. McLaren argued it was not a penalty but was simply aFormula Onerule. McLaren deducted the payment and beat British taxing authorities (HMRC) in court.

Fines are often linked to bribes, another prohibited deduction. But here, too, some are deductible. In SEC v. Bilzerian, Mr. Bilzerian paid off a stockbroker. Bilzerian deducted it even though he was convicted of securities violations and conspiring to defraud the IRS. The IRS disallowed the deduction saying the payoff was illegal.

But in Tax Court Bilzerian got his deduction. Only payments illegal by themselvesare nondeductible, the court ruled. See IRS Cracking Down on Government Settlements. There is often considerable grey area that encourages taxpayers to claim deductions.

Robert W. Wood practices law with Wood LLP, in San Francisco. The author of more than 30 books, including Taxation of Damage Awards & Settlement Payments (4th Ed. 2009 with 2012 Supplement, Tax Institute), he can be reached atWood@WoodLLP.com. This discussion is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.

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